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A former Fed chair still wants the punch bowl — and a high-proof punch

Federal Reserve Board Chairman Ben Bernanke testifies before the Senate Banking Committee in 2012. (Win McNamee/Getty Images)
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Federal Reserve Chairman William McChesney Martin spoke for generations of monetary policymakers when he famously declared in 1955 that the job of the central bank was to take away the punch bowl “just when the party was really warming up.”

But in recent years, this puritanical approach to managing the ups and downs of the economy had fallen into disrepute. Citing structural changes in the economy and the lessons learned from the two most recent recessions, central bankers have come to believe that they must “do whatever it takes” to pull an economy out of a serious downturn and keep the cheap money flowing until the economy has fully recovered — and then some. Taking away the punch bowl too early, they have come to believe, results in jobless recoveries in which the economy never reaches its full potential and workers never gain the leverage to bargain for a decent wage.

Among the intellectual godfathers for this more muscular, run-it-hot monetary policy, none is more respected than Ben Bernanke, the Princeton academic who courageously and creatively led the Fed into and through the Great Recession. In his latest book, “21st Century Monetary Policy: The Federal Reserve from the Great Inflation to COVID-19,” Bernanke aims to build public support for this new monetary framework.

Unfortunately for Bernanke, however, his book arrives just as this new framework is being put to the test, with an inflationary spiral taking hold, an economic slowdown on the horizon, and tech and crypto bubbles starting to burst. Earlier this month, as the current Fed chair and his colleagues scrambled to hike interest rates and halt a multi-trillion-dollar bond-buying spree, a somewhat-chastened Jerome Powell admitted that they had left the punch bowl out too long.

You can tell from its title that this is not a book aimed at the bestseller list. Half is given over to a history of Federal Reserve policy from the Johnson administration to the present. That is followed by a remarkably accessible but unavoidably wonkish discussion of the extraordinary steps taken by the Fed and other central banks in the wake of the 2008 financial crisis and then again during the recent pandemic. Readers will be treated to a spirited defense of inflation-targeting but skepticism toward nominal GDP-targeting; a nuanced explanation of the difference between “forward guidance” of the Delphic and Odyssean varieties; a celebration of the success of “quantitative easing,” which has allowed central banks to stimulate the economy even after interest rates have fallen to zero; and an impassioned plea for central bank independence from political interference. There’s even an elegant put-down of Modern Monetary Theory, a recently fashionable fantasy of unlimited government borrowing that has captured the imagination of the libertarian right and the free-spending left. Anyone looking for the score settling, mea culpas and juicy anecdotes usually found in books by Washington insiders will be disappointed.

Indeed, one of the weaknesses of the book is that Bernanke cannot seem to bring himself to say anything critical about any of his Fed colleagues — or, for that matter, any of his predecessors or successors — or the insular Fed culture that remains smugly dismissive of critics and dissenters, overreliant on its economic models and willfully ignorant of the machinations on Wall Street.

For example, Bernanke rightfully criticizes former president Donald Trump and other politicians who have tried to politicize the Fed, but sees no contradiction in describing how the agency lobbied Congress in 2010 to preserve its role as the leading bank regulator, including recruiting the support for the banks it regulates.

Bernanke seems to have forgotten his own role, under a previous Fed chairman, in the excessive consolidation and deregulation of banks and financial markets that continue to destabilize markets and the economy to this day.

And even though it is more than a decade since he left the Fed for a research sinecure at the Brookings Institution, Bernanke clings to the obfuscating and euphemistic language of the central banker — insisting, for example, that when the Fed buys trillions of dollars of government bonds to stimulate the economy, it does so not by “printing money” but by “creating bank reserves.”

Particularly unconvincing is Bernanke’s assertion that the expansionary monetary policy he supports does not favor the rich or significantly contribute to income inequality. Bernanke acknowledges that one intended effect of such policies is to artificially raise the price of stocks and other financial assets that are owned disproportionately by the rich. But he argues that those policies also have a similar effect of increasing employment, income home values and retirement savings of the middle and working classes.

Unfortunately, any broad look at the data confirms what most of us see all around us: that the dramatically increased wealth of those in the top 10 percent overwhelms the modest gains of everyone else as that wealth is invested and converted to income. Bernanke’s analysis betrays a surprisingly shallow understanding of the dynamics of inequality in the 21st-century economy.

Bernanke’s problem, like that of many of his Fed colleagues past and present, is a refusal to acknowledge the prevalence of asset bubbles, the extent of their impact on the economy and the Fed’s role in creating them, both through expansionary monetary policy and weak financial regulation. It was this blind spot about the irrationality and games-playing on Wall Street that led Bernanke to assure the country in 2008 that the subprime mortgage market was simply too small to threaten the banking system. And it is the same blind spot that allowed the Fed in recent years to dismiss the meme stocks, the tech unicorns and the crypto insanity, along with the explosion of private credit, and characterize it as nothing more than one of those occasional exuberances unworthy of a policy response. In both instances, Fed officials relied on comforting data analyses that betrayed breathtaking naivete about the behavior of Wall Street wiseguys and dynamics of financial markets.

Under the asymmetric monetary framework that Bernanke lays out and the Fed now embraces, the central bank will keep interest rates “lower for longer” during recessions and recoveries but won’t keep them higher for longer when the economy is booming. The Fed will print up trillions of dollars to fight one recession but never manage to withdraw them before the next one begins. To fight recessions, it will encourage undue risk taking by speculative investors, money managers and corporate executives, providing them with oodles of cheap money and assuring them that it won’t be withdrawn anytime soon. And when the inevitable bubble bursts and it all comes crashing down, the Fed will be there once again to do “whatever it takes” to rescue the financial system and save risk-takers from the full consequences of their actions.

This framework, in effect, creates a one-way monetary ratchet that requires ever-increasing doses of monetary stimulus to maintain the economy at full employment, in the process creating a floor under asset prices with only a vague hint there might be a ceiling. Its fixation on “forward guidance” about future Fed moves invites everyone on financial markets to lean in the same direction while constraining the Fed from responding quickly to changing conditions. And although Bernanke, like his successors, may claim they’re doing it all for the little guy, the clear message it sends to the Wall Street is, We’ve Got Your Back!

In the coming months, the Fed will try to rescue this strategy with a series of sharp rate increases and gradual withdrawal of bank reserves, moves that it hopes can tame inflation without throwing the economy into recession. If the Fed succeeds in engineering such a “soft landing,” Bernanke’s book could see a second printing as it becomes the go-to text for courses in monetary policy.

But if the strategy fails, the result is likely to be an extended period of uncomfortably high inflation and uncomfortably high unemployment. Such “stagflation” is particularly confounding for central bankers, as any move to solve one problem is likely to exacerbate the other. In that event, the most likely place to find a copy of “21st Century Monetary Policy” will be the remainder bin of your local bookstore.

Steven Pearlstein is a former business and economics columnist for The Washington Post. He is also the Robinson Professor of Public Affairs at George Mason University.

21st Century Monetary Policy

The Federal Reserve from the Great Inflation to COVID-19

By Ben S. Bernanke

Norton. 480 pp. $35